“Charitable Behavior”

Our society is fortunate that so many business owners are charitably inclined.

In many cases, their charitable activities are motivated purely by a desire to help others, whether the object of their assistance is a favorite social welfare agency, museum, school or university, religious institution, hospital, scientific research organization, or you name it.[i]

In others, this charitable bent is often accompanied by a desire for some public acknowledgement of the owner’s charitable activities, or perhaps recognition of the contributions made by their business to the communities in which it operates.[ii]

Reward the Good, Punish the “Not so Good”

As a general rule, the tax laws seek to encourage and facilitate the transfer of wealth from private persons – like a business and its owners – to charitable entities.[iii] Because the assets so transferred become dedicated to the public purposes served by these charities, the use and disposition of the assets become subject to regulation by the government. Thus, the Code includes a number of provisions that seek to encourage what is perceived to be “good” behavior, and to discourage what is perceived to be “unacceptable” behavior. The Code punishes such behavior.[iv]

Although it hardly rises to the level of what may commonly be viewed as “bad” behavior, the conduct of unrelated business[v] activities by a charity – whether directly, or indirectly through a pass-through entity like a partnership or LLC – is scrutinized by the IRS,[vi] and the profits therefrom are subject to tax in the hands of the charity at the flat 21-percent rate applicable to taxable C corporations.[vii]

Investment income fares better than unrelated business income because it represents the return on a “passive” activity. Such income – which includes, for example, dividends, interest, rent, and the gain from the sale of the property that produces such income – is generally not taxable unless the charity incurred debt in order to acquire the income-producing property, thereby diverting assets away from its charitable mission.[viii]

In the case of a private foundation, however, even investment income generated by property that was not the object of acquisition indebtedness is subject to a two-percent federal tax.[ix]

Real Property

Among the assets that are often transferred to a charity are interests in real property, including those that generate rental income.

Such property may be a good choice for a contribution to a private foundation organized by the business or by its owners. The property will likely have appreciated in value over time; at the same time, its basis will have been reduced by depreciation[x] – something that other investment assets can’t do. The result is a large built-in gain inherent in the property.[xi]

In order to avoid the recognition of this gain, and to fund the operation of the private foundation, a business or its owners may contribute the property to the foundation.[xii]

In any event, the subsequent sale of the property by the foundation – a not unlikely event because most foundations don’t want to be in the business of managing real property – would generally not be subject to income tax.[xiii]

Gift Acceptance Vehicle

In some cases, the charity will accept a contribution of a direct interest in such real property, following which the charity may drop the property into a wholly-owned LLC or corporation in order to shield its charitable assets from any liabilities that may arise with respect to the property. In others, the charity may insist that the owner first contribute the property to such an entity before the charity will accept the donation.[xiv]

More recently, charities have formed subsidiary LLCs – that are treated as disregarded entities for tax purposes[xv] – for the sole purpose of accepting a gift of real property.[xvi]

Like any other “business,”[xvii] a charity that is thinking of acquiring real property, whether by acceptance of a donation or by purchase, is also thinking about how it may shield its other assets – especially those that are directly used in its charitable mission – from any liabilities that may arise out of the charity’s ownership (however brief) of the real property.

NY and NYC Transfer Taxes

The favorable disposition toward charities that is found in the federal tax rules is often lacking under many provisions of state and local tax law for which there are no federal counterparts; in particular, I am thinking about New York State’s (“NY”) real estate transfer tax, which imposes a tax – payable by the transferor in the first instance – on certain conveyances of real property or of an interest therein.[xviii]

Any private donor of NY real property, and any charitable recipient of such property, has to be mindful of the cost of the NY real estate transfer tax that will be incurred on the charity’s subsequent sale of the property. They have to be even more careful of not incurring NYC’s real property transfer tax.[xix]

Direct Transfers by Charities

The transfer by a charity of an interest in NY real property[xx] is not identified under NY’s Tax Law as one of the transfers that is exempted from the tax; such a transfer, therefore, is subject to the NY transfer tax.[xxi]

The NYC Administrative Code,[xxii] however, provides that the sale by a charity of an interest in real property located in NYC is not subject to the RPTT.

Thus, the sale by a charity of an interest in NYC real property will be subject to NY transfer tax but will not be subject to the RPTT.

Indirect Transfers?

But what about an indirect sale of an interest in NYC real property? For example, what if the charity was a member of a partnership that owned, operated, and eventually sold NYC real property?


In general, a member of a partnership (including an LLC treated as a partnership for tax purposes) is allocated its distributive share of the partnership’s items of income, gain, deduction, loss, and credit for purposes of determining the member’s income tax liability.[xxiii]

What’s more, under general tax principles, the activities of a partnership are often considered to be the activities of the partners.[xxiv] In other words, a member of a partnership is treated as being engaged in the activities in which the partnership is engaged.

Similarly, the character of any item of partnership gain that is allocated to a member of the partnership is determined as if it were realized directly from the source from which realized by the partnership.[xxv] For example, if a partnership were to sell a real property that it had operated as a rental property, the gain from the sale would be treated as Section 1231 capital gain in the hands of its members, including a charity.[xxvi]

Such gain is generally excluded from the unrelated business income of a charity that is a member of the selling partnership.[xxvii] The fact that the property was actually sold by the partnership of which the charity was an owner does not change the nature of the gain in the hands of the charity (as to its distributive share). The charity is treated as having sold that portion of the property itself for purposes of determining the tax treatment for the charity’s share of the gain.[xxviii]

How do these concepts apply to the RPTT? Specifically, will a charity have to bear a portion of the economic cost of the RPTT imposed upon a partnership with respect to its sale of NYC real property? Or will the charity’s distributive share of the gross proceeds from the partnership’s sale of such property be exempted from the imposition of the RPTT?

According to a recent decision of the NYC Tax Appeals Tribunal (the “Tribunal”), the charity-partner will be treated the same as any other partner for these purposes.[xxix]

The Charity

Charity was formed in 1996, and in 1997 it was recognized[xxx] by the IRS as a tax-exempt organization described in Sec. 501(c)(3) of the Code, and as a grant-making private foundation.[xxxi]

According to Charity’s 2016 federal tax return,[xxxii] the Charity acquired a one-third interest in a partnership[xxxiii] (“Partnership”) from a related business corporation.[xxxiv] It appears that this interest in Partnership constituted Charity’s principal asset.

Sale and Refund Claim

In 2017, Partnership sold a real property that it owned in NYC for over $83 million.[xxxv] Partnership reported the sale on the appropriate transfer tax returns, and paid almost $2.2 million of combined NY and NYC transfer taxes, as determined on those returns.[xxxvi]

Charity filed a claim for refund with NYC in which it asserted that one-third of the RPTT paid by Partnership – corresponding to its one-third interest in Partnership – should be returned to Charity because Charity was exempted from payment of the RPTT.[xxxvii]

After the refund claim was disallowed, Charity requested a conciliation conference, but the conferee sustained the disallowance of the claim for refund. Charity then petitioned the Tribunal to contest the conferee’s decision.

The Petition

NYC moved to dismiss Charity’s petition, arguing that the petition failed to state a cause for relief because the entity which sold the real property and paid the RPTT – Partnership –was not tax-exempt and, accordingly, there was no exemption from the tax and no basis for a refund claim.

According to NYC, Charity did not pay the tax and, therefore, could not claim a refund.

In addition, NYC argued that no exemption from RPTT was available where the transfer was by an entity which was not tax-exempt, regardless of whether any of its owners were tax-exempt.

That being said, NYC conceded that no RPTT would have been due if Charity, rather than Partnership, had sold the real property.

Charity argued that the RPTT exemption for transfers by tax-exempt entities should be treated like the exemption for a “mere change in form,” and recognized to the extent that a seller was owned by a tax-exempt entity. In other words, one should look through a partnership to the beneficial owner of the property to determine the application of the exemption.

Charity also argued that the transaction could have been structured so that the exemption would apply.[xxxviii]

The Tribunal

The Tribunal began by noting that Charity did not have standing to assert a claim for refund of the tax paid by Partnership. Accordingly, as a procedural matter, Charity’s petition had to be dismissed.

Notwithstanding the foregoing conclusion, the Tribunal then turned to the substantive issue presented: the exemption claimed by Charity.

The Tribunal explained that the NYCAC imposes the RPTT on the transfer by deed of real property located within NYC.[xxxix]

The RPTT is also imposed, the Tribunal continued, on “each instrument or transaction . . . whereby any economic interest in real property is transferred . . .”[xl] The tax on transfers of an economic interest applies only where there is no transfer by deed. An “economic interest in real property” is defined as “the ownership of an interest or interests in a partnership, association or other unincorporated entity which owns real property.”[xli]

The Tribunal then stated that the taxpayer has the burden of proving entitlement to an exemption: “Exemption . . . provisions are to be construed in favor of the taxing authority, and . . . a taxpayer must prove entitlement.”

With that, the Tribunal turned to the two exemptions claimed by Charity. The first exempts charitable organizations from payment of the RPTT; the second exempts transactions to the extent that the beneficial ownership of the grantor and the grantee is the same.

According to the Tribunal, the first exemption[xlii] provides that the RPTT shall not apply to:

“[a] deed, instrument or transaction conveying or transferring real property or an economic interest therein by . . . any corporation . . . organized or operated exclusively for religious, charitable, or educational purposes, or for the prevention of cruelty to children or animals, and no part of the net earnings of which inures to the benefit of any private shareholder or individual and no substantial part of the activities of which is carrying on propaganda, or otherwise attempting to influence legislation . . .”

The parties agreed that Charity satisfied this definition, and that had Charity itself conveyed the property, the sale would have been exempt from RPTT.

Charity relied, by analogy, on the provisions of the second exemption,[xliii] which provides an exemption for a deed, instrument or transaction conveying or transferring real property or an economic interest therein that “effects a mere change of identity or form of ownership or organization to the extent the beneficial ownership of such real property or economic interest therein remains the same.”

Charity posited that the exemption for transfers by tax-exempt entities should be applied by considering the ownership of the entity selling the real property. Therefore, since Charity owned one-third of the partnership making the sale, the RPTT owing on the sale should be reduced to that extent.

The Tribunal considered Charity’s argument, and found that the exemption was “not susceptible to the interpretation urged by” Charity. It stated that, when construing a statute, courts are to discern and give effect to the legislature’s intent. Moreover, it continued, an exemption must be narrowly construed.

The Tribunal found there was nothing in the statute to suggest that the exemption applied to entities which were not themselves tax-exempt (like the Partnership), to the extent that they were owned by tax-exempt entities (like Charity).

Moreover, the mere change in form provision Charity relied upon states that it applies “to the extent the beneficial ownership” of the real property or economic interest remains the same. The Tribunal found that the exemption for tax-exempt entities does not contain language indicating that the exemption applies to the extent that a tax-exempt entity owns an interest in the seller. Instead, the exemption requires that the seller be a tax-exempt entity.

Because the Partnership was not a tax-exempt entity, the exemption from RPTT was not available.

Charity’s argument that it transferred an economic interest in Property was also rejected. The RPTT is imposed, the Tribunal stated, on a transfer of an economic interest only where the transfer is not evidenced by a deed subject to the RPTT. Because the transfer at issue was by deed, no economic interest in the Property was transferred for purposes of the RPTT.

On the basis of the foregoing, the Tribunal dismissed Charity’s petition and sustained the disallowance of the refund claim.

What’s Next?

It remains to be seen whether Charity will appeal the Tribunal’s decision. I hope it does.

Leaving that possibility aside, and accepting the Tribunal’s reasoning for the moment, are there other circumstances under which the Tribunal might reach a different decision notwithstanding that a charity is not the actual seller?

What if the will of a decedent had directed the executor of the decedent’s estate to sell certain real property and to distribute the net proceeds therefrom to a charity within, say, two years of the decedent’s date of death, failing which the property itself would be distributed to the charity?

Does the foregoing fact pattern support a conclusion that the interest in real property had, in fact, “passed” to the charity upon the decedent’s death, and that the executor of the decedent’s estate was acting merely as the charity’s agent in the sale?[xliv]

Stay tuned.

[i] We will refer to these as “charities;” basically, an organization described in IRC Sec. 501(c)(3).

[ii] Should it matter what motivates the donor if the effect or impact of their “generosity” on the charity and its mission is the same? Call it “charitable realpolitik.” It is the basis for “naming opportunities” ranging from entire buildings, to rooms within those buildings, to seats in a theatre, to bricks outside a school.

[iii] The tax laws operate to reduce the economic cost of transferring assets to a charity. That being said, the tax benefit enjoyed by a donor for a contribution to a public charity will be greater, under current rules, than for an identical contribution by the same donor to a private foundation.

[iv] It does so by imposing a tax upon the charity and, in appropriate circumstances, upon the charity’s officers and directors, as well as other “disqualified” persons. For example, see IRC Sec. 4941 (self-dealing with respect to a private foundation) and IRC Sec. 4958 (excess benefits provided by a public charity to certain “insiders”).

Also keep in mind the role of the States Attorneys General – the People’s lawyers – in the realm of charitable organizations. Because the public is the ultimate beneficiary of a charity’s activities, the charity has to realize that it is ultimately subject to the supervision of the Attorney General of the State in which it is organized or operates.

[v] Unrelated to the performance of the function or purpose that constitutes the basis for the entity’s tax exemption. IRC Sec. 513.

[vi] To ensure they remain an insubstantial part of a charity’s activities.

[vii] IRC Sec. 511 et seq.; IRC Sec. 11.

[viii] IRC Sec. 512(b) and Sec. 514.

[ix] IRC Sec. 4940. The rate may be reduced to 1% in certain circumstances.

[x] IRC Sec. 167 and Sec. 1016.

[xi] That would be realized upon its sale. IRC Sec. 1001.

[xii] Unfortunately, the charitable income tax deduction generated by an inter vivos contribution would be limited to the donor’s adjusted basis for the property. IRC Sec. 170(e). Unless the foundation was an operating foundation.

Of course, if the property had “passed” from a recently deceased taxpayer to the donor-taxpayer, the basis would have been stepped-up to fair market value. IRC Sec. 1014 and Sec. 1015.

[xiii] IRC Sec. 512(b)(5). Of course, the assignment of income doctrine has to be considered lest the whole plan be for naught. https://www.taxlawforchb.com/2018/10/assignment-of-income-and-charitable-contributions-of-closely-held-stock/

[xiv] Although a corporation may be formed under a state’s not-for-profit or non-stock corporation law – and operate as a title-holding company or as a supporting organization, for tax purposes – most LLC statutes, including NY’s, contemplate only for-profit business purposes. Of course, an LLC’s articles of organization may limit its “business” activities to those of its related charitable member.

[xv] Reg. Sec. 301.7701-3.

[xvi] See IRS Notice 2012-52.

[xvii] Let’s face it, in many endeavors, the lines between a pure business and a pure charity have blurred.

[xviii] NY Tax Law Sec. 1402.

[xix] “RPTT”.

[xx] Whether it is a direct interest, or a controlling interest in an entity that owns NY real property.

[xxi] Similarly, the sale of such real property to a charity is also subject to the tax.

[xxii] “NYCAC”.

[xxiii] IRC Sec. 702.

[xxiv] See, e.g., Rev. Rul. 98-15, IRC Sec. 512(c), Sec. 875.

[xxv] IRC Sec. 702.

[xxvi] IRC Sec. 1231. See also IRC Sec. 1221.

[xxvii] IRC Sec. 512(c) and Sec. 512(b)(5).

[xxviii] IRC Sec. 702(a)(3) and Sec. 702(b).

[xxix] In re Jacob & Anita Penzer Found., Inc., N.Y.C. Tax App. Trib. A.L.J. Div., No. TAT (H) 18-18 (RP), 7/31/19.

[xxx] IRC Sec. 508.

[xxxi] Under Sec. 509(a) of the Code.

[xxxii] IRS Form 990-PF. See Guidestar.org. It’s amazing how much information is available on a tax return.

[xxxiii] Probably one of many owned and managed by the investment firm, Ascot Properties Co. Query who the other partners were?

[xxxiv] Penco Fabrics Inc., a closely held business. The contribution was made in two parts: in September and in November of 2016. It appears that the family of the Charity’s founders controlled Penco.

[xxxv] The sale was in February of 2017. It is likely, when Penco contributed its interest in Partnership to Charity (in September and November of 2016), that Partnership and the buyer were already in discussions for the sale of the property.

Charity reported over $25 million as its share of the gain from Partnership’s sale of the property.

It is unclear if this was Partnership’s only real estate asset, or if Partnership liquidated after the transaction.

[xxxvi] For 2017, the NYS real estate transfer tax rate was 0.40%, and the NYC real property transfer tax rate was 2.625%; a total of 3.03%.

[xxxvii] NYCAC Sec. 11-2106.b(2).

[xxxviii] For example, by having Charity sell its interest in Partnership to the buyer, by having Partnership redeem Charity’s interest prior to the sale of the property, or by distributing the property to the partners as tenants-in-common and letting them sell the property.

Query how reasonable this statement was in light of the timing of the contribution of the Partnership interest to Charity and the subsequent sale by the Partnership?

Query also how much control or influence Charity would have had over the structure of the sale?

[xxxix] NYCAC Sec. 11-2102.a

[xl] NYCAC Sec. 11.2102.b.

[xli] NYCAC Sec. 11-2101.6.

[xlii] NYCAC Sec. 11-2106.b(2)

[xliii] NYCAC Sec. 11-2106.b(8).

[xliv] Matter of Petition of E/O Eugene Schwartz, 1995 WL 376858.